state of maine supreme judicial court sitting as the … · 2019-09-11 · state of maine . supreme...
TRANSCRIPT
STATE OF MAINE SUPREME JUDICIAL COURT
SITTING AS THE LAW COURT
LAW DOCKET NO. BCD-18-524
STATE TAX ASSESSOR Appellee/Cross-Appellant
v.
KRAFT FOODS GROUP, INC., et al. Appellants/Cross-Appellees
ON APPEAL FROM CUMBERLAND COUNTY SUPERIOR COURT BUSINESS AND CONSUMER DOCKET
BRIEF OF APPELLEE/CROSS-APPELLANT STATE TAX ASSESSOR
AARON M. FREY Attorney General
THOMAS A. KNOWLTON Assistant Attorney General KIMBERLY L. PATWARDHAN Assistant Attorney General Office of the Attorney General SUSAN P. HERMAN 6 State House Station Deputy Attorney General Augusta, Maine 04333-0006 (207) 626-8800 Of Counsel Attorneys for Appellee
i
TABLE OF CONTENTS
Page TABLE OF AUTHORITIES ......................................................................................................... iii INTRODUCTION............................................................................................................................. 1 APPLICABLE LAW ........................................................................................................................ 4 STATEMENT OF FACTS ............................................................................................................ 10 STATEMENT OF ISSUES PRESENTED ................................................................................ 20 SUMMARY OF ARGUMENT ..................................................................................................... 21 ARGUMENT ................................................................................................................................... 22 I. The Superior Court correctly held that Kraft failed to prove that
it was entitled to alternative apportionment under 36 M.R.S.A. § 5211(17) ......................................................................................................................... 22 A. Kraft failed to prove that the regular apportionment
provisions “do not fairly represent the extent of the taxpayer’s business activity in this State.” .............................................. 24
B. Kraft failed to prove that its proposed method is “reasonable” and “effectuate[s] an equitable apportionment of the taxpayer’s income.” .............................................. 32
C. Alternative apportionment is not constitutionally required .......... 34
II. The Superior Court correctly upheld part of the penalty in the First
Assessment, but erred in abating a portion of that penalty ...................... 37
A. Kraft failed to prove it had substantial authority for its filing position or establish grounds constituting reasonable cause ................................................................................................ 39
ii
1. Kraft’s state income tax returns depicted a unitary business................................................................................................. 40
2. Kraft Foods Inc. and its affiliates exhibited strong
centralized management, economies of scale, and functional integration .................................................................................... 40
a. Kraft had strong centralized management. ............................... 41
b. Functional integration and economies of scale ....................... 43
i. KFG provided centralized services to all Kraft affiliates ................................................................................ 43 ii. Kraft’s business operations were linked ............................ 45
3. The few facts and legal arguments on which Kraft
relied do not amount to substantial authority or establish reasonable cause ........................................................................... 46
B. Kraft did not provide substantial authority to
support any claim that the $1.3 billion earned by KFGB was “non-unitary” income ................................................................. 49
III. The Second Assessment was timely .................................................................... 51 CONCLUSION ................................................................................................................................ 55
CERTIFICATE OF SERVICE ...................................................................................................... 56 CERTIFICATE OF SIGNATURE ............................................................................................... 57 ADDENDUM ................................................................................................................................... 58
iii
TABLE OF AUTHORITIES
CASES Page Albany Int’l Corp. v. Halperin, 388 A.2d 902 (Me. 1978) ............................................... 5 Allied-Signal, Inc. v. Director, Div. of Tax’n, 504 U.S. 768 (1992) ...................... 5, 6, 8 Angell v. Hallee, 2014 ME 72, 92 A.3d 1154 ...................................................... 22, 37, 51 Citizens Utils. Co. of Ill. v. Dep’t of Rev., 488 N.E.2d 984 (Ill. 1986) .......... 41, 42, 46 Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) ........................................... 6 Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159 (1983) ................. passim Earth Res. Co. of Alaska v. Dep’t of Rev., 665 P.2d 960 (Alaska 1983) ................... 44 E.I. DuPont de Nemours & Co. v. State Tax Assessor, 675 A.2d 82 (Me. 1996) ...................................................................................................................................... 23 E.I. DuPont de Nemours & Co. v. State Tax Assessor, BCD-AP-09-09 (Me. Bus. & Consumer Ct. Oct. 26, 2010, Humphrey, C.J.) .................................. 23, 28 Exxon Corp. v. Wisc. Dep’t of Rev., 447 U.S. 207 (1980) .................................. 8, 37, 40 Foster v. Oral Surgery Assocs., P.A., 2008 ME 21, 940 A.2d 1102 .................... 31, 50 Gannett Co. v. State Tax Assessor, 2008 ME 171, 959 A.2d 741 ...................... passim General Mills, Inc. v. Franchise Tax Bd., 208 Cal. App. 4th 1290 (2012) ...................................................................................................................................... 27, 28 John Swenson Granite, Inc. v. State Tax Assessor, 685 A.2d 425 (Me. 1996) .............................................................................................................................. 39, 49 Meadwestvaco Corp. v. Ill. Dep’t of Rev., 553 U.S. 16 (2008) ...................................... 50 Microsoft Corp. v. Franchise Tax Bd., 139 P.3d 1169 (Cal. 2006) .................... 27, 28
iv
Mobil Oil Corp. v. Comm’r of Taxes, 445 U.S. 425 (1980) .............................................. 7 Moorman Mfg. Co. v. Bair, 427 U.S. 267 (1978) ................................................................ 5 Pennzoil Co. v. Department of Revenue, 33 P.3d 314 (Ore. 2001), cert. denied, 535 U.S. 927 (2002) .................................................................................. 36, 37 R.H. Macy & Co. v. Lindley, 495 N.E.2d 948 (Ohio 1986) ............................................. 10 Roger Dean Enters v. Fla. Dep’t of Rev., 387 So.2d 358 (Fla. 1980) ................ 23, 24 Sears, Roebuck & Co. v. State Tax Assessor, 561 A.2d 172 (Me. 1989) ........... 23, 24 St. Johnsbury Trucking Co. v. New Hampshire, 385 A.2d 215 (N.H. 1978) ........... 24 Tambrands, Inc. v. State Tax Assessor, 595 A.2d 1039 (Me. 1991) ......................... 23 Twentieth Century-Fox Film Corp. v. Dep’t of Rev., 700 P.2d 1035 (Ore. 1985) (en banc) ................................................................................................................ 24 Warnquist v. State Tax Assessor, 2019 ME 19 .................................................. 22, 33, 37 FEDERAL RULES
26 C.F.R. § 1.6662-4(d)(2) ............................................................................................... 39, 48
26 C.F.R. § 1.6662-4(d)(3) ............................................................................................... 39, 48
26 C.F.R. § 1.6662-4(d)(3)(iii) ............................................................................................... 39
MAINE RULES
18-125 C.M.R. ch. 801 § .02 ........................................................................................... 7, 8, 40
M.R. Evid. 602 ............................................................................................................................... 16
M.R. Evid. 801-802 ..................................................................................................................... 16
v
MAINE STATUTES 36 M.R.S.A. § 141(2) (Supp. 2018) .................................................................. 3, 21, 52, 53 36 M.R.S.A. § 151(2)(G) (Supp. 2018) ................................................................................ 51 36 M.R.S.A. § 151-D(10)(I) (Supp. 2018) .................................................................. 22, 37 36 M.R.S.A. § 187-B (Supp. 2018) ................................................................................ 21, 38 36 M.R.S.A. § 187-B(4-A) (Supp. 2018) ..................................................................... 37, 38 36 M.R.S.A. § 187-B(7) (Supp. 2018) .................................................................................. 38 36 M.R.S.A. § 5102(10-A) (Supp. 2018) ....................................................................... 5, 40 36 M.R.S.A. § 5200-A(2)(F) (Supp. 2018) .................................................................... 2, 18 36 M.R.S.A. § 5210 (2010 & Supp. 2018) ............................................................................ 4 36 M.R.S.A. § 5211 .................................................................................................................... 4, 5 36 M.R.S.A. § 5211(8) .................................................................................................................. 5 36 M.R.S.A. § 5211(14) (Supp. 2018) ................................................................................... 9 36 M.R.S.A. § 5211(17) (Supp. 2018) ........................................................................ passim 36 M.R.S.A. § 5220(5) (Supp. 2018) ...................................................................................... 9 36 M.R.S.A. § 5244 (2010) ......................................................................................................... 9 P.L. 1987, ch. 841, §§ 9-13 (eff. Aug. 4, 1988) ................................................................. 49
1
INTRODUCTION
During the years at issue, Kraft Foods Inc. and its affiliates comprised a
unitary business that manufactured and sold many food and beverage
products, including Nabisco crackers and cookies, Kraft cheeses, and DiGiorno
frozen pizzas.1 Kraft also owned and managed valuable trademarks, patents,
and other intellectual property (“IP”) related to its food and beverage products.
In 2010, Kraft sold to Nestle USA, Inc. and its affiliates most of the assets
from its frozen pizza business, including trademarks, patents, and other IP
owned by Kraft Foods Global Brands, Inc., the Kraft affiliate that managed all
the Kraft IP (“KFGB”), and by Kraft Pizza Company (“KPC”). The sale to Nestle
resulted in roughly $3.3 billion in federal taxable income to Kraft. The majority
of that income came from the sale of IP, not equipment or frozen pizzas. That
income was recognized by three Kraft entities, KPC (roughly $2 billion), KFGB
(roughly $1.3 billion), and Kraft Foods Global, Inc. (“KFG”) ($340,000).
When Kraft filed its 2010 Maine income tax return, it excluded from the
income subject to Maine tax all of the $3.3 billion in income from the Nestle sale.
1 The Assessor uses “Kraft” to refer to the Kraft affiliated group generally. This appeal focuses on the activities of 3 Kraft affiliates: Kraft Pizza Company (“KPC”), Kraft Foods Global Brands, Inc. (“KFGB”), and Kraft Foods Global, Inc. (“KFG”). For ease of reference, pertinent portions of Joint Exhibit 6, the Kraft organizational chart as of 12/31/09, are attached to this Brief as an Addendum.
2
Kraft subtracted roughly $3 billion of it pursuant to 36 M.R.S.A. § 5200-A(2)(F)
(Supp. 2018) on the theory that it was “non-unitary income.”
This matter involves two adjustments that the Assessor made to Kraft’s
2010 Maine income tax return – resulting in two tax assessments. In the first
assessment, the Assessor disallowed the $3+ billion subtraction and assessed
$1,832,717 in tax, statutory interest, and a substantial understatement penalty.
Kraft appealed the Assessor’s final agency action upholding the first
assessment to the Board of Tax Appeals (“Board”). Kraft argued that KPC was
not part of its unitary business and pressed an alternative argument: if the $3+
billion in income was taxable by Maine, then Kraft was entitled to alternative
apportionment under 36 M.R.S.A. § 5211(17) (Supp. 2018). Kraft also argued
that the penalty should be abated. The Board accepted Kraft’s arguments on
alternative apportionment and penalty abatement.
The Assessor appealed the Board decision to Superior Court, where Kraft
changed its arguments. Kraft conceded that KPC was part of its unitary
business and the $3+ billion in income from the Nestle sale was taxable by
Maine. Kraft pressed its claims for alternative apportionment and penalty
abatement. The Superior Court (Murphy, J.) rejected Kraft’s alternative
apportionment claim, upheld part (about 1/3) of the penalty from the first
assessment, and abated the rest of that penalty.
3
As for the second assessment, the Assessor disallowed a $306,729,484
“capital loss carryforward” (“CLC”) that Kraft claimed on its 2010 Maine income
tax return. Kraft had no legal basis to claim the CLC, which had the effect of
excluding from Maine income tax the remainder of the $3.3 billion in income
from the Nestle sale. MRS issued a supplemental assessment for $192,448 in
tax, statutory interest, and a substantial understatement penalty. Kraft
appealed the Assessor’s final agency action upholding the second assessment
directly to Superior Court, where it argued only that the second assessment was
not timely under 36 M.R.S.A. § 141(2) (Supp. 2018). The appeal of the second
assessment was consolidated with the appeal of the first assessment. The
Superior Court held that the second assessment was timely.
Kraft is trying to avoid paying its fair share of Maine income tax on its
$3.3 billion taxable gain. The State is seeking to tax just 0.7026% (7/10 of 1%)
of Kraft’s 2010 income – roughly the same fraction as in 2008 and 2009. The
Court should (1) affirm the Superior Court’s order rejecting Kraft’s alternative
apportionment claim, (2) affirm that order to the extent it upheld the penalty
in the first assessment, but vacate it to the extent that it abated the penalty in
the first assessment, and remand for entry of judgment in the Assessor’s favor
as to the whole penalty, and (3) affirm the order as to the second assessment.
4
APPLICABLE LAW
Formula apportionment. When a corporation and its affiliates do
business in several states, each state must determine how much of the
corporations’ income and losses are attributable to one state as opposed to
another. To accomplish this division of income fairly, Maine, like more than 20
other states, has enacted a tax method based on the Uniform Division of Income
for Tax Purposes Act. See 36 M.R.S.A. §§ 5210-11 (2010 & Supp. 2018). This
method is often referred to as the unitary business, or “formula
apportionment,” method. See Gannett Co. v. State Tax Assessor, 2008 ME 171,
¶¶ 12-13, 959 A.2d 741.
Under this method, to ascertain the taxable income of a multi-state
unitary business that operates through several affiliated corporations, all of the
affiliated corporations – including the ones that do not have a presence, or
“nexus,” in Maine – are grouped as a single unit (unitary business), and the
incomes of all these affiliates are aggregated. In other words, the income of all
the corporations with nexus in Maine is aggregated with the income of all other
affiliated corporations comprising the unitary business, regardless of whether
those other corporations also have nexus in Maine. The aggregate income of
the unitary business is then “apportioned” among all the states in which the
5
unitary business operates according to a statutory formula. 36 M.R.S.A. § 5211;
Gannett, 2008 ME 171, ¶ 12, 959 A.2d 741.
Under this method, Maine taxes an apportioned share of the entire
income of the unitary business.2 “[W]e permit States to tax a corporation on an
apportionable share of the multistate business carried on in part in the taxing
State. That is the unitary business principle.” Allied-Signal, Inc. v. Director, Div.
of Tax’n, 504 U.S. 768, 778 (1992) (emphasis added).
The apportionment formula “provides a method for attributing to a state,
for the purpose of income taxation, a portion of the total income of a multi-state
or a multi-national business that is carrying on some of its regular activity
within the state.” Albany Int’l Corp. v. Halperin, 388 A.2d 902, 905 (Me. 1978).
The apportionment factor is deemed to accurately reflect that portion of the
unitary business’ income that is attributable to a particular state. See Container
Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159, 170-84 (1983); Moorman Mfg.
Co. v. Bair, 427 U.S. 267, 272-81 (1978).
Unitary business. A unitary business is a business activity “characterized
by unity of ownership, functional integration, centralization of management
and economies of scale.” 36 M.R.S.A. § 5102(10-A) (Supp. 2018); Gannett, 2008
2 For the years at issue, income was apportioned to Maine by the sales factor. 36 M.R.S.A. § 5211(8).
6
ME 171, ¶ 13, 959 A.2d 741. The unitary business concept ignores the separate
legal existence of corporations (which are easily manipulable) and focuses on
practical business realities and transfers of value among affiliated corporations.
Allied-Signal, 504 U.S. at 783; Gannett, 2008 ME 171, ¶ 13, 959 A.2d 741.
A unitary business has “some sharing or exchange of value not capable of
precise identification or measurement” because of the mutual interdependence
among affiliated corporations and the attendant substantial flows of value
between them. Gannett, 2008 ME 171, ¶¶ 13, 15, 959 A.2d 741 (quotation
marks omitted). When a multistate business operates as a unitary business, it
is fair to include the income from out-of-state activities in determining the
income that is apportionable to Maine. See id. ¶¶ 11-12.
The Supreme Court has identified several criteria to evaluate whether a
state may treat a multi-state business as a unitary business consistent with the
Due Process and Commerce Clauses.3 In Container, the Court held that “[t]he
prerequisite to a constitutionally acceptable finding of unitary business is a
3 The Due Process Clause imposes 2 requirements on state taxation of income earned in interstate commerce: (1) a minimal connection (nexus) “between the interstate activities and the taxing State” and (2) a “rational relationship between the income attributed to the State and the intrastate values of the enterprise.” Container, 463 U.S. at 165-66 (quotation marks omitted). The Commerce Clause imposes 4 requirements on a State’s taxation of interstate activities: (1) the activity must have a substantial nexus with the taxing State; (2) the tax must not discriminate against interstate commerce; (3) the tax must be fairly apportioned, in terms of both internal consistency and external consistency; and (4) the tax must be rationally related to the services provided by the State. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977).
7
flow of value, not a flow of goods.... [A] relevant question in the unitary business
inquiry is whether contributions to income [of the subsidiaries] result[ed] from
functional integration, centralization of management, and economies of scale.”
Container, 463 U.S. at 178-79 (quotation marks omitted) (emphasis added).
The issue of whether a business is unitary is determined on a case-by-
case basis, in light of all relevant facts and circumstances. The Maine statutory
test of a unitary business mirrors the Supreme Court’s formulation as set out in
Mobil Oil Corp. v. Comm’r of Taxes, 445 U.S. 425, 438 (1980), and Container.4
Maine Revenue Services’ Rule 801 sets out some circumstances when
affiliated corporations are unitary. For tax year 2010, Rule 801.02 stated in part:
The activities of a corporation or group of affiliated corporations constitute a unitary business if those activities are integrated with, dependent upon and contributive to each other and to the operations of the corporation or group as a whole. The presence of any of the following factors creates a strong presumption that the activities of the corporation or group constitute a single trade or business:
A. All activities are in the same general line or type of business; [or]
. . . . C. The corporation or group is characterized by strong
centralized management, including but not limited to
4 All the hallmarks of a unitary business need not exist to find that a group of affiliated corporations is a unitary business. See Container, 463 U.S. at 166, 179.
8
centralized departments for such functions as financing, purchasing, advertising and research.
18-125 C.M.R. ch. 801 § .02 [hereinafter, Rule 801].
As long as income derives from a unitary business, part of which is
conducted in Maine, then Maine may tax a portion of all the income of the entire
unitary business. See Allied-Signal, 504 U.S. at 778. “[A] State need not attempt
to isolate the intrastate income-producing activities from the rest of the
business; it may tax an apportioned sum of the corporation’s multistate
business if the business is unitary.” Id. at 772-73.5
Having determined that a certain set of corporations comprise a unitary
business, a state may apply its apportionment formula to all income from the
unitary business as long as the formula complies with the Due Process and
Commerce Clauses. An apportionment formula’s application will be upheld
unless the taxpayer proves by “clear and cogent evidence” that, as applied in its
case, the resulting income is “out of all appropriate proportion to the business
5 To exclude certain income from the apportionment formula, a taxpayer must prove that “the income was earned in the course of activities” unrelated to the activities of the unitary business. Allied-Signal, 504 U.S. at 787 (quotation marks omitted). That is, income may be excluded from the apportionable income of the unitary business if the taxpayer proves that it was derived from an “unrelated business activity” that “constitutes a discrete business enterprise.” Exxon Corp. v. Wisc. Dep’t of Rev., 447 U.S 207, 223 (1980) (quotation marks omitted).
9
transacted by the [taxpayer] in that State” or that the apportionment formula
has led to a “grossly distorted result.” Container, 463 U.S. at 170, 180-81.
Combined Report. Under 36 M.R.S.A. § 5220(5) (Supp. 2018), a
corporation that is a member of an affiliated group and engaged in a unitary
business with one or more members of that group is required to file, in addition
to a tax return, a “combined report” in accordance with 36 M.R.S.A. § 5244
(2010). Combined reports require, among other things, a listing of the federal
taxable income of each member of the unitary business and their sales in Maine
and everywhere.
Recap. There are three basic steps involved in every Maine corporate
income tax matter. The first step is identifying the corporation or corporations
that comprise the unitary business or businesses at issue. There is no dispute
that Kraft’s affiliated group, including KPC and KFGB, comprised a unitary
business. The second step is determining the income that is apportionable to
Maine and subject to tax. There is no dispute about that amount here. The third
step is calculating the apportionment factor. That is the principal disputed
issue in this case. Kraft objects to using the regular apportionment factor under
36 M.R.S.A. § 5211(14) (Supp. 2018) – 0.7026%, similar to its factor in both
2008 and 2009 – to apportion all the income from its unitary business in 2010.
10
STATEMENT OF FACTS
Kraft’s unitary business. At all relevant times, Kraft Foods Inc. (no comma
between “Foods” and “Inc.”) was the parent of the Kraft affiliated group.
Appendix (“A.”) 204-05. Kraft Foods Inc. owned 100% of the stock of KFG,6
which in turn owned 100% of the stock of KPC, KFGB, and many other Kraft
affiliates. A. 204, 226; Joint Exhibits (“Jt. Exs.”) 6 & 7; see Addendum to Brief.
At all relevant times, through its own activities and many affiliates, Kraft
Foods Inc. operated a horizontally integrated,7 unitary business in Maine and
other states involving the manufacture, sale, and distribution of food and
beverage products, including snacks, cheeses, coffee, and juice pouches. A. 205-
11; Jt. Ex. 8. The Kraft brands included such notable names as Kraft cheese,
Nabisco cookies, DiGiorno and Tombstone frozen pizza, and Capri juice
pouches. A. 203, 205, 208. These products were manufactured and sold in the
United States and worldwide. Kraft’s unitary business also included the
management and protection of valuable IP associated with its food and
beverage products, including trademarks and patents. A. 211-17.
Many of the Kraft affiliates were involved in the manufacture and sale of
these products. Kraft Foods Inc. was a holding company and had one employee.
6 Kraft Foods Global, Inc. changed its name to Kraft Foods Group, Inc. in 2012. A. 236. 7 A horizontally integrated business is one whose segments operate related activities in several states. R.H. Macy & Co. v. Lindley, 495 N.E.2d 948, 950 n.1 (Ohio 1986).
11
A. 205. KFG (Kraft Foods Global, Inc.) was the main corporate operating entity.
KFG had the most employees and was involved in the manufacture and sale of
most Kraft food and beverage products. A. 205.
IP operations. Because the bulk of the $3+ billion in gain from the Nestle
sale derived from the sale of trademarks, patents, and other IP, the stipulated
facts concerning these activities are critical. Kraft owned IP for such well-
known brands as Oreo, Nabisco, DiGiorno, and Planters. This case involves the
sale to Nestle of patents, trademarks, and other IP used in the manufacture and
sale of DiGiorno, Tombstone, Jack’s, and Delissio frozen pizzas.
In 1999, Kraft formed a separate corporation to manage and protect its
IP. A. 211. In 1999 and thereafter, Kraft Foods, Inc. (with a comma between
“Foods” and “Inc.”) transferred certain trademarks and patents to a corporation
known as Kraft Foods Holdings, Inc. A. 211. The IP that was transferred
included trademarks for Kraft, Planters, and Oscar Mayer. A. 211. Agreements
entered into in 1999 permitted Kraft Foods, Inc. (renamed Kraft Foods North
America, Inc. in 2001 and then KFG in 2004) to manufacture, market, sell, and
distribute products using the IP that had been transferred to Kraft Foods
Holdings, Inc. A. 211. In other words, starting in 1999, Kraft separated most of
its IP from the related food or beverage products. The corporation that owned
the IP (Kraft Foods Holdings, Inc. and then its successor Kraft Foods Global
12
Brands, Inc. (KFGB)) collected a royalty every time one of the products subject
to the 1999 agreements (i.e., Oreo cookies, etc.) was sold by KFG.
The 1999 agreements involving Kraft Foods Holdings, Inc., however, did
not govern (A) trademarks owned by KPC (the Tombstone and Jack’s
trademarks), (B) the DiGiorno and Delissio trademarks (owned by Kraft Foods
Holdings, Inc. and then its successor KFGB), and (C) IP owned by Capri Sun, Inc.,
Churny Company, Inc., Boca Foods Company, and Seven Seas Foods, Inc. A. 212.
There was no written agreement that governed KPC’s use of the DiGiorno and
Delissio trademarks and the patents used in the manufacture of frozen pizza,
which were owned by Kraft Foods Holdings, Inc. and then by its successor KFGB.
A. 212. KPC did not pay any royalties when it sold DiGiorno and Delissio frozen
pizzas – even though KFGB – not KPC – owned the valuable DiGiorno and
Delissio trademarks. A. 215.
During 2001-2007, Kraft Foods Holdings, Inc. served two main functions:
(A) it conducted research and development (R&D) for all Kraft affiliates,
including KPC; and (B) it managed and protected the IP that it owned (including
DiGiorno and Delissio trademarks), the IP that KPC owned (i.e., Tombstone and
Jack’s trademarks), and the IP that was owned by other Kraft affiliates. A. 212-
13. At all relevant times, the IP owned by Kraft Foods Holdings, Inc. and its
successor KFGB included the trademarks for Kraft, DiGiorno, Delissio, and Oreo,
13
as well as various patents, including the “rising crust” patent for DiGiorno
frozen pizzas. A. 214.
In 1999, Kraft Foods Holdings, Inc. and Kraft Foods, Inc. entered into a
services agreement (1999 Services Agreement). The 1999 Services Agreement
remained in effect from 1999-2011 and governed the services that Kraft Foods,
Inc. (renamed Kraft Foods North America, Inc. in 2001 and KFG in 2004)
provided to Kraft Foods Holdings, Inc. and then to its successor KFGB. These
services included human resources, legal, accounting, tax, treasury, and risk
management services. A. 213.
KFGB was formed in December 2007 to be the successor entity to Kraft
Foods Holdings, Inc. A. 214. At all relevant times, KFGB owned, among other
IP, the majority of the IP related to the frozen pizzas sold by KPC, including the
DiGiorno and Delissio trademarks and all the patents related to the frozen pizza
business. A. 214. Like its predecessor, KFGB served two principal functions:
(A) it conducted R&D for all Kraft affiliates; and (B) it managed and protected
the IP that it owned, the IP that KPC owned (i.e., the Tombstone and Jack’s
trademarks), and the IP that other Kraft affiliates owned. Id. There were 10-15
lawyers employed by KFGB that managed and protected the Kraft IP. A. 194.
From December 2007-2011, pursuant to the 1999 License Agreement,
KFGB generally received a royalty payment of 9% of net sales of products using
14
trademarks subject to the 1999 License Agreement. For example, if KFG sold a
box of Oreos for $3, then KFG paid a royalty of 27 cents (9% of $3) to KFGB on
that sale. In both 2009 and 2010, KFG paid more than $2,000,000,000 in
royalties to KFGB on sales of products using IP owned by KFGB. A. 214-15. The
net effect of this arrangement was to substantially reduce the taxable income
of KFG and increase the taxable income of KFGB. A. 235; Jt. Ex. 3.
As noted above, KPC did not pay any royalties on its sales of frozen pizza
using the DiGiorno and Delissio trademarks, even though KFGB owned the
trademarks. KPC did not pay for its use of valuable patents in its frozen pizza
business, even though the patents were owned by KFGB. A. 215. The net effect
of this favorable intercompany arrangement was to vastly increase KPC’s
annual income – KPC did not pay any royalties or fees on valuable IP owned by
other Kraft affiliates when manufacturing and selling much of its frozen pizza.
To illustrate the value of this arrangement, consider the license that KPC
had to sell California Pizza Kitchen (“CPK”) frozen pizzas. In 2009 and 2010,
KPC paid $7,990,985 and $3,882,985, respectively, in royalties to CPK, Inc. on
KPC’s sales of frozen pizza using a trademark owned by CPK, Inc. A. 215-16.
The activities of KFGB during 2008 to 2010 contributed to the value of
the IP owned by KFGB, including the pizza-related IP and the IP related to foods
sold by KFG. A. 215-216. The activities of KFGB also contributed to the value
15
of the pizza-related IP owned by KPC. A. 215-16. Among other activities, KFGB
protected and managed all the pizza-related IP during that time. A. 214.
Likewise, KPC contributed to the value of the DiGiorno and Delissio
trademarks and other pizza-related IP owned by KFGB by, among other ways,
selling quality frozen pizza and maintaining/improving name recognition.
KFGB did not pay KPC for these activities. A. 216. KPC contributed to the value
of the Tombstone and Jack’s trademarks (which KPC owned) by, among other
ways, selling quality frozen pizza and maintaining or improving name
recognition. Id. In short, there was a powerful synergy between KPC and KFGB
as to the creation and increase in value of the pizza-related IP. A. 214-16.
Likewise, the activities of KFG (parent company of KFGB and KPC)
contributed to the value of the IP owned by KFGB by, among other ways, selling
quality food and beverage products and maintaining or improving name
recognition. A. 216. There was also a strong synergy between KFG and KFGB.
A. 214-16.
During 2005-2010, KPC and KFGB “together were mutually acting
beneficially to benefit the value of the pizza-related IP.” A. 216. During 2005-
2010, KFG and KFGB “together were mutually acting beneficially to benefit the
value of” the IP owned by KFGB related to foods sold by KFG, such as trademarks
for Kraft and Planters. A. 216-17.
16
Centralized services. At all relevant times, KFG provided numerous
centralized services to all Kraft affiliates, including KPC. A. 219-24. The
services that KFG provided to KPC and other Kraft affiliates included human
resources, property management, pension management, legal, payroll,
treasury, tax, accounting, internal audit, risk management, advertising,
purchasing, and marketing. A. 220-21.
Sale of Assets. On January 4, 2010, KFG, Kraft Foods Global Brands LLC,
KPC, and Kraft Canada Inc. entered into an agreement with Nestle to sell to
Nestle certain assets used in the business of Kraft Foods Inc.8 and affiliates
relating to frozen pizza and other frozen food products similar to pizza (“Nestle
Agreement”). A. 231. Nestle acquired the DiGiorno, Tombstone, Jack’s, and
Delissio trademarks, the license to use the CPK trademark; patents related to
frozen pizza manufacturing, and tangible and intangible property used in the
development, manufacturing, marketing, sale, and distribution of frozen pizzas
and similar frozen food products. A. 231-32; Jt. Exs. 27-37.
Nestle paid $3,692,835,676 for the Frozen Food Assets as follows: it paid
$2,358,056,241 to KPC, including for the Tombstone and Jack’s trademarks; it
paid $1,321,300,00 to KFGB for IP, including for the DiGiorno and Delissio
8 The Irene Rosenfeld memorandum cited by Kraft (Bl. Br. at 1-2) is inadmissible hearsay. See A. 166 (citing M.R. Evid. 602 & 801-802). The trial court did not appear to give it weight.
17
trademarks and patents related to frozen pizzas; and it paid $340,000 to KFG
for a non-compete agreement.9 A. 232-33.
As part of the Nestle Agreement, KFG agreed to provide Nestle with sales,
R&D, distribution, and other services for up to two years via a Transition
Services Agreement (“TSA”). A. 232; Jt. Exs. 39-40. Nestle paid Kraft roughly
$30 million during 2010 and 2011 for services that Kraft provided pursuant to
the TSA. A. 232.
The Nestle sale resulted in a large gain to Kraft. On its 2010 federal income
tax return, Kraft reported taxable income on the Nestle sale in the total amount
of $3,349,462,365, broken down as follows: KPC reported $2,028,162,365 in
income; and KFGB reported $1,321,300,000 in income. A. 233; Jt. Ex. 48 at 4-5.
Kraft’s unitary filings. From no later than 2001 through 2011, Kraft filed
income tax returns in Maine that depicted a unitary business that included KPC
and KFGB. A. 233. By including KPC and the IP operations as part of its unitary
business, Kraft repeatedly avowed, under oath, that all its affiliates were “a
functionally integrated enterprise whose parts are mutually interdependent
such that there is a substantial flow of value between them.” Gannett, 2008 ME
171, ¶ 13, 959 A.2d 741.
9 Kraft’s allegation that “Nestle did not pay for a license to use the Kraft name,” Bl. Br. at 2, is contradicted by the stipulated record. A. 136-37.
18
In particular, in October 2011, Kraft filed a 2010 Maine income tax return
that depicted a unitary business that included KPC and KFGB. A. 234. Kraft
reported KPC’s income from the sale of its frozen pizzas as part of the income
of the unitary business subject to Maine income tax. A. 234.
On that 2010 Maine return, Kraft reported $3,179,725,852 in total federal
taxable income, $502,197,939 in total Maine net income, a Maine
apportionment factor of 0.008193 (or 0.8193%), and Maine income tax due of
$367,402. A. 235; Jt. Ex. 3. Relying on 36 M.R.S.A. § 5200-A(2)(F), Kraft claimed
a subtraction modification for income it asserted was not constitutionally
taxable in the total amount of $3,004,347,614, broken down as follows: KPC
subtracted $1,989,777,098 and KFGB subtracted $1,014,570,516. A. 234. The
$3,004,347,614 that was subtracted was part of the federal taxable income of
Kraft Foods Inc. and affiliates that resulted from the sale to Nestle. A. 234. Kraft
later claimed that it subtracted the $3+ billion because it was “non-unitary”
income. A. 239.
First Assessment. Maine Revenue Services (“MRS”) examined Kraft’s
2010 and 2011 Maine income tax returns. A. 237-38. Despite having reported
KPC and KFGB as part of its unitary business for many years, Kraft deducted
$3+ billion in income from the Nestle sale on its 2010 Maine return, claiming it
was “non-unitary” income. On audit, MRS disagreed and adjusted Kraft’s 2010
19
Maine return to include that income as subject to Maine income tax.10 A. 237-
38. MRS issued an assessment for $1,832,717 in tax, plus interest and a
substantial understatement penalty (“First Assessment”), which MRS upheld
on reconsideration. A. 238. Kraft appealed that decision to the Board.
Board proceedings. Before the Board, Kraft asserted that KPC was not
part of its unitary business and that $3+ billion in income from the sale to Nestle
was not subject to tax by Maine. A. 238-39. In the alternative, Kraft requested
alternative apportionment pursuant to 36 M.R.S.A. § 5211(17) based on a
methodology that would use two separate apportionment factors for 2010: one
factor to apportion the $3+ billion in income from the Nestle sale and another
factor to apportion the other income from the Kraft unitary business. A. 239.
The Board concluded that Kraft was a unitary business. A. 62-65.
However, the Board accepted Kraft’s argument for alternative apportionment
and appeared to adopt one of the factors Kraft suggested to the Board
(0.3322%). A. 65-66. The Board also abated the penalty. A. 67-69. The
Assessor appealed the Board’s decision to the Superior Court. A. 33-70.
Second Assessment. MRS further reviewed Kraft’s 2010 Maine tax return
and disallowed the $306,729,484 CLC. A. 239. MRS determined that Kraft had
10 On audit, MRS also reduced Kraft’s 2010 Maine apportionment factor by adding to the denominator the gross receipts from the sale to Nestle. A. 237.
20
no legal basis to claim the CLC. MRS issued a supplemental assessment for
$192,448 in tax, with interest and a substantial understatement penalty
(“Second Assessment”), which MRS upheld on reconsideration. A. 239. Kraft
appealed that final agency action directly to the Superior Court.
Superior Court. The two Superior Court appeals were transferred to the
Business Court and consolidated. A. 10. The parties filed cross-motions for
summary judgment based primarily on an extensive stipulated record. Kraft
also submitted a supporting affidavit. After oral argument, the Superior Court
issued a decision largely affirming both final agency actions, which upheld most
of the First Assessment and all of the Second Assessment. A. 13-32. The court
abated part of the penalty in the First Assessment. Id. Kraft appealed the
Superior Court’s judgment, and the Assessor cross-appealed.
STATEMENT OF ISSUES PRESENTED
I. Whether the Superior Court correctly held that Kraft failed to prove that it was entitled to alternative apportionment under 36 M.R.S.A. § 5211(17).
II. Whether the Superior Court correctly upheld part of the penalty
included in the First Assessment, but erred in abating a portion of that penalty.
III. Whether the Superior Court properly held that the Second
Assessment was timely.
21
SUMMARY OF ARGUMENT
I. Alternative apportionment under section 5211(17) is the rare
exception that is reserved for the few cases where the regular apportionment
formula does not fairly reflect a taxpayer’s business activities in a state due to
a corporation’s unique or unusual characteristics. Kraft wants to use section
5211(17) simply to pay less Maine income tax on its 2010 profits. As the trial
court ruled, section 5211(17) “is not simply a mechanism for lowering a
corporation’s tax liability when the corporation is assessed a larger-than-
normal tax bill resulting from a single highly profitable transaction.” A. 25.
II. Kraft failed to prove there was “substantial authority” for its 2010
filing position or to establish grounds constituting “reasonable cause,” see 36
M.R.S.A. § 187-B (Supp. 2018), where Kraft subtracted $3+ billion from the
income subject to tax by Maine on the theory that it was “non-unitary income.”
The Superior Court properly ruled that Kraft did not have substantial authority
to subtract any of the $1.3 billion recognized by KFGB, but erred in ruling that
Kraft had substantial authority to subtract the $2 billion recognized by KPC.
III. The Second Assessment was timely under 36 M.R.S.A. § 141(2).
The tax liability shown on Kraft’s 2010 Maine income tax return was less than
one-half of the tax liability as determined by the Assessor, even assuming that
Kraft had substantial authority to subtract the $2 billion recognized by KPC.
22
ARGUMENT
I. The Superior Court correctly held that Kraft failed to prove that it was entitled to alternative apportionment under 36 M.R.S.A. § 5211(17).
This Court reviews de novo whether a dispute of material fact exists and
whether the entry of a summary judgment was proper as a matter of law. Angell
v. Hallee, 2014 ME 72, ¶¶ 16-17, 92 A.3d 1154. Kraft has the burden of proof
on all factual and legal issues. 36 M.R.S.A. § 151-D(10)(I) (Supp. 2018). The
Superior Court conducted a de novo proceeding on the Assessor’s petition for
review and made its own determinations as to all questions of fact and law. No
deference may be given to the Board’s decision or the Assessor’s final agency
action. Warnquist v. State Tax Assessor, 2019 ME 19, ¶ 12.
Kraft contends it is entitled to alternative apportionment under 36
M.R.S.A. § 5211(17). To obtain relief under section 5211(17), Kraft must prove
that (1) “the apportionment provisions of [Maine law] do not fairly represent
the extent of the taxpayer’s business activity in this State” and (2) the
alternative method proposed by Kraft was “reasonable” and “effectuate[s] an
equitable apportionment of the taxpayer’s income.” 36 M.R.S.A. § 5211(17).
Burden of proof. The burden of proof on a taxpayer is clear and convincing
evidence when it seeks alternative apportionment based on an argument that
Maine’s regular apportionment formula is unconstitutional. Gannett, 2008 ME
23
171, ¶¶ 34-36, 959 A.2d 741; Tambrands, Inc. v. State Tax Assessor, 595 A.2d
1039, 1045 (Me. 1991). Kraft has made such an argument here. Bl. Br. at 23.
This Court also held that the burden of proof on a taxpayer is clear and
convincing evidence when it seeks to challenge the Assessor’s use of alternative
apportionment. E.I. DuPont de Nemours & Co. v. State Tax Assessor, 675 A.2d 82,
90-91 (Me. 1996); E.I. DuPont de Nemours & Co. v. State Tax Assessor, BCD-AP-
09-09 (Me. Bus. & Consumer Ct. Oct. 26, 2010, Humphrey, C.J.), at 10-11.
Under the logic of Gannett, DuPont, and Tambrands, clear and convincing
evidence is the correct burden of proof where the taxpayer seeks to use
alternative apportionment based upon section 5211(17). The trial court erred
in holding that Kraft’s burden was by preponderance of the evidence. A. 19.
Even assuming Kraft’s burden is preponderance of the evidence, the
trial court correctly held that Kraft fell far short of proving what it was
required to prove under section 5211(17). A. 19-23.
Alternative apportionment is the rare exception. Statutory alternative
apportionment is reserved for the rare case when the regular apportionment
formula does not fairly reflect a taxpayer’s business activities due to its unique
or unusual characteristics. DuPont, 675 A.2d at 89; Sears, Roebuck & Co. v. State
Tax Assessor, 561 A.2d 172, 173 (Me. 1989). There is a very strong presumption
against alternative apportionment; it is the rare exception. See Roger Dean
24
Enters. v. Fla. Dep’t of Rev., 387 So.2d 358, 362-64 (Fla. 1980) (“very strong
presumption” against alternative apportionment); St. Johnsbury Trucking Co. v.
New Hampshire, 385 A.2d 215, 217 (N.H. 1978) (“alternative formula is the
exception”). The purpose of formula apportionment would be undermined if
taxpayers could obtain alternative apportionment based only on a showing that
their method resulted in less tax.
A. Kraft failed to prove that the regular apportionment provisions “do not fairly represent the extent of the taxpayer’s business activity in this State.”
Under section 5211(17), Kraft first must show that the regular
apportionment formula does not fairly represent “the extent of [its] business
activity” in Maine during 2010. 36 M.R.S.A. § 5211(17) (emphasis added); see
Sears, 561 A.2d at 173. Kraft failed to make the required showing.
Kraft’s argument is based on a flawed legal premise – that it only needs
to show that the regular apportionment formula does not adequately reflect
how certain income is earned in the state. Bl. Br. at 9-23. Kraft’s argument
misreads section 5211(17) and is contrary to established case law. See
Twentieth Century-Fox Film Corp. v. Dep’t of Rev., 700 P.2d 1035, 1042-43 (Ore.
1985) (en banc); Sears, 561 A.2d at 173. Again, to gain relief under section
5211(17), Kraft must show that the regular apportionment formula does not
fairly reflect the extent of its business activities in Maine during 2010.
25
The regular apportionment factor – 0.7026% – fairly represented the
extent of the business activities in Maine of KPC and the rest of Kraft’s unitary
business in 2010. A. 22. Many Kraft affiliates sold their food and beverage
products in Maine in 2010, and the regular apportionment formula fairly
reflected that activity:
• KFG sold its products in Maine in 2010, including Kraft cheese, Nabisco cookies, and Planters snacks ($159,395,586 in Maine sales)
• KPC sold frozen pizzas in Maine in 2010 ($1,109,108 in Maine sales)
• Capri Sun, Inc. sold juice pouches in Maine in 2010 ($12,878,716 in Maine sales)
• Churny Company sold specialty cheese products in Maine in 2010
($1,347,185 in Maine sales)
• Other Kraft affiliates sold products in Maine in 2010, including Cadbury Adams USA LLC, Boca Foods Co., Seven Seas Foods, Inc., Victor Th. Engwall & Co., and Tassimo Corporation (totaling roughly $2 million in Maine sales).
A. 230-31.
Kraft’s 2010 Maine regular apportionment factor (0.7026%) was similar
to its reported Maine apportionment factors for 2008 (0.6971%) and 2009
(0.7370%). A. 233-34. The nature and extent of Kraft’s business activities in
Maine did not change materially during those years. Thus, as the Superior
Court properly held, application of the regular apportionment formula “fairly
26
represents the extent of Kraft’s frozen pizza-related business activities in
Maine, just as it does for the rest of Kraft’s product lines.” A. 22.
In support of its alternative apportionment argument, Kraft contends
(without record support) that the $3+ billion from the Nestle sale was “an
extraordinary, one-time capital gain” and a “one-time extraordinary activity.”
Blue Br. at 9, 11. Indeed, Kraft characterizes the Nestle sale or the capital gain
as “extraordinary” eight times in its brief, Bl. Br. at 3, 9, 11, 12, 16, 24, 30, as if
invoking that word were determinative of what it needed to prove.
The Assessor agrees this was the one time that Kraft sold these assets, but
not the one time that Kraft had a large gain or loss in 2007-2010. A. 196-98.
Moreover, the record shows that Kraft’s decision to sell off part of its business
in 2010 was not an extraordinary event, as Kraft had done similar deals before
and after 2010, leading to large capital gains and losses. A. 189-90, 236.
Acquisitions and divestitures were part of Kraft’s business. A. 189-90, 236.
To be sure, Kraft’s unitary business, which had substantial activity in
Maine in 2008-2010, had the good fortune to be much more profitable in 2010
than in 2009. Maine is entitled to an apportioned share (7/10 of 1%) of that
larger amount of income. See Gannett, 2008 ME 171, ¶¶ 28-36, 959 A.2d 741.
That is how formula apportionment and the unitary business principle work. Id.
27
Moreover, as the trial court explained, the claim that the $3+ billion
resulted from a “one-time extraordinary gain” (assuming it were supported by
the record) does not advance Kraft’s section 5211(17) argument – that “the
apportionment provisions of this section do not fairly represent the extent of
the taxpayer’s business activity in this State” in 2010. A. 20-25. As the court
ruled, section 5211(17) “is not simply a mechanism for lowering a
corporation’s tax liability when the corporation is assessed a larger-than-
normal tax bill resulting from a single highly profitable transaction.” A. 25.
No qualitative distortion. For the first time on appeal, Kraft tries
unsuccessfully to shoe-horn its case into the facts of two decisions from
California, General Mills, Inc. v. Franchise Tax Bd., 208 Cal. App. 4th 1290 (2012)
and Microsoft Corp. v. Franchise Tax Bd., 139 P.3d 1169 (Cal. 2006). Bl. Br. at
13-23. Both cases involved the situation where certain regular business
activities of corporations – the churning of short-term investments by
corporate treasury departments – were qualitatively different from the rest of
the corporations’ business activities, and inclusion of the gross proceeds from
the investment activities unfairly reduced the sales factor by substantially
increasing the denominator. General Mills, 208 Cal. App. 4th at 1294-95;
Microsoft, 139 P.3d at 1171, 1182-83. There, the churning activities of a few
28
employees in one department generated a substantial portion of the
corporations’ gross proceeds, but a relatively small amount of their net income.
In both of those churning cases, the state’s use of alternative
apportionment was upheld because the regular apportionment formula did not
fairly represent the extent of the taxpayer’s business activities. General Mills,
208 Cal. App. 4th at 1294-95, 1316-17; Microsoft, 139 P.3d at 1171, 1182-83.
Use of the regular apportionment formula unfairly reduced the sales factor.
The Maine Superior Court decided a similar case in 2008. See DuPont,
BCD-AP-09-09, at 12-15. The alternative apportionment method that was
approved by the courts in all three cases was inclusion in the sales factor of the
net gain from the transactions, rather than the gross proceeds. That alternative
method addressed the distortive effect of including the gross proceeds from
those churning transactions in the sales factor.
Kraft’s belated attempt to fit its case into those churning cases fails. Kraft
is not seeking relief from the fact that the proceeds from the alleged
“extraordinary event” were included in its sales factor. Those proceeds went
into the denominator of its Maine sales factor and substantially reduced it. A
smaller Maine sales factor resulted in a smaller Maine income tax liability for
2010. Again, unlike General Mills, Microsoft, and DuPont, the inclusion of those
proceeds in the sales factor is not what is in dispute here.
29
What Kraft is arguing is that the $3+ billion in taxable income from the
sale to Nestle should be apportioned to Maine by a smaller factor than the
regular apportionment factor (0.7026%). Kraft contends, in effect, that the
regular apportionment formula does not apply to large capital gains. No court
of which the Assessor is aware has ever adopted such a radical theory.
Kraft’s unitary business, which had substantial activity in Maine in 2008,
2009, and 2010, had the good fortune to be much more profitable in 2010 than
in 2009. Maine is entitled to an apportioned share (7/10 of 1%) of that larger
amount of income. Gannett, 2008 ME 171, ¶¶ 28-36, 959 A.2d 741.
Moreover, the allegation that the $3+ billion resulted from a “one-time
extraordinary gain” (even assuming it was supported by the record) does
nothing to support what Kraft must prove under section 5211(17) – that “the
apportionment provisions of this section do not fairly represent the extent of
the taxpayer’s business activity in this State” in 2010. A. 20-21. Kraft simply
wants to use section 5211(17) to pay less Maine income tax on its 2010 profits.
The Court should reject Kraft’s claim.
No quantitative distortion. Kraft spends ten pages analyzing three facts:
(1) the taxable income from the Nestle sale was much larger than the taxable
income from the rest of the unitary business in 2010; (2) most of the $3.6 billion
in gross receipts from the Nestle sale constituted federal taxable income to
30
Kraft; and (3) Kraft sold relatively fewer pizzas in Maine in 2010 as compared
to other states and as compared to sales in Maine of certain other Kraft food
and beverage products (e.g., Kraft cheeses and Nabisco cookies/crackers). Bl.
Br. at 17-26. But none of those facts proves there was any “quantitative
distortion” from using Kraft’s regular Maine apportionment factor in 2010.
The point of formula apportionment is to use the unitary business’
overall apportionment factor (which is in effect an average) to apportion all the
unitary business’ income. The fact that KPC’s 2010 Maine sales factor was
smaller than some Kraft affiliates (KFG, Capri Sun, and Churny Co.) – but larger
than others (Boca Foods, Victor Th. Engwall, and Seven Seas Foods) – does not
support Kraft’s alternative apportionment theory. The fact that Kraft sold more
pizzas in the Midwest than in Maine does not provide a basis to invoke section
5211(17). Likewise, the fact that one or two members of the unitary business
(KPC and KFGB) had more taxable income in 2010 than other affiliates (such as
KFG) is not a basis for alternative apportionment.11
In addition, the fact that the regular apportionment factor (0.7026%) is
roughly five times larger than one of the fractions Kraft asked the trial court to
11 KFG reported a $614,565,686 loss for 2010 due primarily to its role in the unitary business: intercompany royalty payments to KFGB, interest payments to Kraft Foods Inc. on intercompany promissory notes, and a domestic production activities deduction. A. 235.
31
use (0.1115%) is basic arithmetic, not evidence of “distortion.” KPC’s Maine
activities were integrally related to Kraft’s unitary business enterprise.
As the trial court reasoned, the fact that one member of a unitary business
does relatively more (or less) business in Maine than another member does not
support a claim for alternative apportionment: such a result “would swallow
the general rule” underlying formula apportionment. A. 22-23.
Kraft’s arguments regarding “average profit margin” and “percent of net
income vs. percent of gross receipts” are not supported by the record and
should be rejected. See Bl. Br. at 19-23. The Court should also reject these
arguments because Kraft did not make them below. See Foster v. Oral Surgery
Assocs., P.A., 2008 ME 21, ¶ 22, 940 A.2d 1102.
In any event, neither of these new quantitative arguments shows that use
of the regular apportionment factor (0.7026%) would result in “distortion.” As
the Superior Court explained, Kraft “seems to confuse ‘distortion’ as that word
is used in the case law with what is essentially just an atypically large tax
liability resulting from an atypically profitable tax year.” A. 25.
Kraft cited no case that actually supports its alternative apportionment
claim. As Kraft admits, the California cases on which it relies “present the
reverse” of its factual situation. Bl. Br. at 20 n.9. That is, those California cases,
and the legal principles for which they stand, do not apply here.
32
B. Kraft failed to prove that its proposed method is “reasonable” and “effectuate[s] an equitable apportionment of the taxpayer’s income.”
Under section 5211(17), Kraft must also prove that its proposed method
is “reasonable” and “effectuate[s] an equitable apportionment of the taxpayer’s
income.” Kraft failed to prove these required elements.
It would not be reasonable, and would not effectuate an equitable
apportionment of Kraft’s 2010 income from its unitary business, to use a factor
derived only from KPC’s 2010 sales of frozen pizzas to apportion the $3+ billion
in income from the Nestle sale. That income resulted mostly from the sale of
trademarks, patents, and other IP owned by KFGB and KPC – the value of which
resulted from the mutually beneficial efforts of KFG, KPC, and KFGB. A. 214-19.
As an initial matter, as the court noted, Kraft did not even commit to a
specific alternative factor. A. 22 n.9. Kraft threw out various factors – 0.3322%,
0.2999%, and 0.1115% – each of which would result in divergent tax liabilities,
varying by hundreds of thousands of dollars. Id. Kraft did not prove that its
proposal was reasonable or effectuate an equitable apportionment of its income
in part because Kraft did not even present a definitive alternative proposal.
In addition, Kraft’s alternative apportionment method would result, in
effect, in two unitary businesses. That is contrary to Kraft’s stipulation and the
overwhelming evidence that KPC was part of a single unitary business in 2010.
33
By definition, as a unitary business, the pizza operations were interdependent
with the rest of Kraft. See Gannett, 2008 ME 171, ¶¶ 11-19, 959 A.2d 741. The
stipulated facts summarized above also establish that there was a powerful
synergy between KPC and the rest of Kraft in 2009 and 2010. A. 214-19.
Kraft’s claim that the facts showing that KPC and KFGB were part of a
single unitary business are “entirely irrelevant” to the section 5211(17) inquiry
is flat wrong. See Bl. Br. at 15-16. Kraft failed to prove how it is reasonable or
equitable to use one corporation’s sales (KPC) to apportion income derived
from the synergistic efforts of the members of a unitary business.
Kraft urges the Court to defer to the Board. Bl. Br. at 23-27. The Court
should reject that invitation, as the trial court did. First of all, the factual record
before the Board bears no resemblance to the record before the Superior Court.
In addition, deference to the Board is not permitted, Warnquist, 2019 ME 19, ¶
12, and is not warranted here. The Board’s decision was legally flawed.
Kraft’s claim that the “value of the Pizza Assets was primarily generated
by and is most clearly reflected by KPC’s frozen pizza sales” in 2010 (Bl. Br. at
25) is contrary to the stipulated record. A. 215-19. The Court should reject it.
The Court should also reject Kraft’s unproven and unsupported
contention that “the value of the frozen pizza brands, patents, and related
marketing intangibles and goodwill is derived from the popularity of the frozen
34
pizza with customers.” Bl. Br. at 25. Moreover, Kraft failed to show how this
contention advanced its proposed alternative apportionment method. This
contention is also contrary to the stipulated record. A. 215-19.
C. Alternative apportionment is not constitutionally required.
As a fallback position, Kraft briefly argues that Maine may not tax 0.7026%
of the income from the Nestle sale because that would be “grossly distortive.”
Bl. Br. at 23. Kraft failed to prove its constitutional claim. This Court rejected
that argument on similar facts in Gannett, 2008 ME 171, ¶¶ 28-36, 959 A.2d 741.
An apportionment formula’s application will be upheld unless a taxpayer
proves by “clear and cogent evidence” that, as applied in its case, the resulting
income is “out of all appropriate proportion to the business transacted by the
[taxpayer] in that State” or the formula has led to a “grossly distorted result.”
Container, 463 U.S. at 170, 180-81 (quotation marks omitted). Use of the regular
apportionment formula in 2010 would result in Maine taxing just 7/10 of 1% of
the income from Kraft’s unitary business – a tiny sliver of Kraft’s income. That
number is comparable to Kraft’s reported apportionment factors for 2008 and
2009. A. 233-34. The nature and extent of Kraft’s business activities in Maine
did not change materially during that time.
Further, Kraft’s unitary business had extensive activity in Maine in 2009
and 2010. A. 228-30. KFG had Maine sales of $157,688,676 in 2009 and
35
$159,395,586 in 2010. In 2007-2010, KFG had between 90 and 142 employees
working in Maine and reported Maine payroll of $3,436,869 for 2010 and
$3,434,039 for 2009. A. 228-30. KFG employees traveled to retail stores in
Maine to deliver products and provide assistance on the display of products. Id.
They also served as sales representatives and solicited sales from Maine
retailers. Id.
From 2007 to March 1, 2010, KPC sold frozen pizzas in Maine and
reported $1,109,108 in Maine sales in 2010 (sale to Nestle closed on March 1,
2010), $4,350,242 in Maine sales in 2009, and $3,875,177 in Maine sales in
2008. A. 229-30. During 2008-2010, KPC had seven employees working in
Maine and reported Maine payroll of $126,375 for 2010, $389,868 for 2009,
and $363,045 for 2008. A. 229-30. KPC’s employees delivered frozen pizzas to
stores in Maine, placed them into freezers at Maine stores, provided advice to
Maine retailers on the display of KPC products, and served as sales
representatives for KPC, soliciting sales from Maine retailers. A. 229-30.
During 2008-2010, various Kraft food and beverage products utilizing IP
owned by KFGB were marketed, sold, and distributed in Maine by KPC (e.g.,
DiGiorno pizza) and by KFG (e.g., Oreo cookies, Kraft cheeses, Oscar Mayer
meats, and Planters snacks). A. 230.
36
During 2007-2010, as noted above, many other Kraft affiliates sold their
products in Maine, including Capri Sun, Inc., Churny Company, Inc., Boca Foods
Company, and Victor Th. Engwall & Co., Inc. A. 230-31. Kraft’s activities in
Maine in 2010 were not materially different than in 2008 and 2009.
Kraft failed to show any distortion caused by using the regular
apportionment factor in 2010. The fact that the regular apportionment factor
(0.7026%) is roughly five times larger than one of the fractions Kraft urged the
trial court to adopt (0.1115%) is basic arithmetic, not evidence of distortion.
KPC’s Maine activities were integrally related to Kraft’s unitary business.
No case cited by Kraft stands for the proposition that it is pressing – that
a large increase in income from one year to the next amounts to distortion in a
constitutional sense. Like the taxpayer in Pennzoil Co. v. Department of Revenue,
33 P.3d 314, 318-19 (Ore. 2001), cert. denied, 535 U.S. 927 (2002), Kraft
contends, in effect, that the unitary business principle does not apply to large
gains. The Oregon Supreme Court rejected that argument in Pennzoil,
upholding the taxability of a $2.1 billion settlement received by Pennzoil.
In sum, Kraft’s unitary business, which had substantial and regular
activity in Maine in 2008-2010, was more profitable in 2010 than 2009. Maine
is entitled to an apportioned share (0.7026%) of that larger amount of income.
37
See Gannett, 2008 ME 171, ¶¶ 34-36, 959 A.2d 741; Exxon, 447 U.S. at 226-27;
Pennzoil, 33 P.3d at 318-19 (rejecting distortion claim).
II. The Superior Court correctly upheld part of the penalty in the First Assessment, but erred in abating a portion of that penalty.
The Court reviews de novo whether a dispute of material fact exists and
whether the entry of a summary judgment was proper as a matter of law.
Angell, 2014 ME 72, ¶¶ 16-17, 92 A.3d 1154. Kraft has the burden of proof. 36
M.R.S.A. § 151-D(10)(I). No deference may be given to the Board’s decision or
the Assessor’s final agency action. See Warnquist, 2019 ME 19, ¶ 12
The trial court correctly upheld the penalty in the First Assessment as to
the $1.3 billion recognized by KFGB, but erred in abating the penalty as to the
$2+ billion recognized by KPC. The Assessor cross-appealed from the court’s
decision abating part of the penalty. The trial court incorrectly ruled that
Kraft proved there was “substantial authority,” in part, for its filing position.
Law regarding penalties. One or more penalties may apply when persons
do not comply with Maine’s tax laws. As pertinent here, a person filing a return
“that results in an underpayment of tax, any portion of which is attributable to
a substantial understatement of tax,” is liable for a penalty of up to 25% of the
understatement. 36 M.R.S.A. § 187-B(4-A) (Supp. 2018). “There is a substantial
understatement of tax if the amount of the understatement on the return ...
38
exceeds 10% of the total tax required to be shown on the return.” Id. When
determining whether an understatement of tax is “substantial” and calculating
the amount of a substantial understatement subject to penalty under section
187-B(4-A), “the amount of an understatement is reduced by that portion of the
understatement that is attributable to the tax treatment of any item by the
taxpayer if there is or was substantial authority for that treatment.” Id.
A substantial understatement penalty was imposed in the First
Assessment because the amount of Kraft’s understatement of tax was (far)
more than 10% of the total tax required to be shown on the 2010 return.
The Assessor shall abate penalties “if grounds constituting reasonable
cause are established by the taxpayer or if the assessor determines that
grounds constituting reasonable cause are otherwise apparent.” 36 M.R.S.A.
§ 187-B(7) (Supp. 2018). Section 187-B(7) contains a non-exclusive list of
circumstances that constitute reasonable cause, none of which applies here.
Although Kraft stipulated below that KPC was part of its unitary business
in 2010, Kraft argues that the penalty should be abated because (1) there was
“substantial authority” for its filing position (i.e., $3+ billion of income earned
by the unitary business was “non-unitary” income) or (2) it had established
“reasonable cause.” See 36 M.R.S.A. § 187-B. Bl. Br. at 27-28.
39
“Substantial authority is ‘an objective standard involving an analysis of
the law and application of the law to relevant facts.’” John Swenson Granite, Inc.
v. State Tax Assessor, 685 A.2d 425, 429 & n.3 (Me. 1996) (quoting 26 C.F.R. §
1.6662-4(d)(2)). “There is substantial authority for the tax treatment of an
item only if the weight of the authorities supporting the treatment is substantial
in relation to the weight of authorities supporting contrary treatment.” Id.
(quoting 26 C.F.R. § 1.6662-4(d)(3)). The substantial authority inquiry is
primarily law-based. See 26 C.F.R. § 1.6662-4(d)(3)(iii) (listing authorities on
which taxpayers may rely). “Substantial” means something less than a
preponderance, but more than a mere “reasonable basis.” Id.
C. Kraft failed to prove it had substantial authority for its filing position or establish grounds constituting reasonable cause.
Kraft did not cite any authority supporting its filing position – that $3+
billion in income earned by its unitary business was non-unitary income. There
was not substantial authority to support that position. In addition, Kraft did not
establish grounds constituting reasonable cause. The issue of whether Kraft was
a unitary business is controlled by Gannett, 2008 ME 171, 959 A.2d 741.
At the Board, Kraft argued that KPC was not part of its unitary business.
Kraft’s arguments morphed at the Superior Court, where it stipulated that KPC
was part of its unitary business, but argued that “a reasonable person could
40
reach a contrary determination.” Bl. Br. at 31. As shown below, the record
shows overwhelming evidence that Kraft was a unitary business that included
KPC.12 See Gannett, 2008 ME 171, ¶¶ 20-27, 959 A.2d 741.
4. Kraft’s state income tax returns depicted a unitary business.
For many years, including 2009-2011, Kraft filed Maine income tax
returns under oath depicting a unitary business that included KPC. Kraft also
filed as a unitary business in many other states for those years. A. 233-36.
These many admissions foreclose any suggestion now that KPC was not really
part of its unitary business. See Gannett, 2008 ME 171, ¶¶ 6-7, 959 A.2d 741.
5. Kraft Foods Inc. and its affiliates exhibited strong centralized management, economies of scale, and functional integration.
Kraft Foods Inc. and its affiliates, including KPC and KFGB, exhibited the
hallmarks of a unitary business: strong centralized management, economies of
scale, and functional integration. 36 M.R.S.A. § 5102(10-A); Gannett, 2008 ME
171, ¶ 13, 959 A.2d 741. Under Rule 801.02, there is a presumption of a unitary
business here for at least two reasons: (A) all the activities are in the same
12 Income may be excluded as non-unitary income if the taxpayer proves that the income derived from an “unrelated business activity” that “constitutes a discrete business enterprise.” Exxon, 447 U.S at 223 (quotation marks omitted); see also Gannett, 2008 ME 171, ¶¶ 28-29, 959 A.2d 741. Kraft has not tried to prove that the $3+ billion at issue met this standard. Instead, Kraft has sought to defend its filing position by proving that KPC was arguably not part of its unitary business in 2010.
41
general line or type of business and (B) the affiliated group is characterized by
strong centralized management, as shown below.
a. Kraft had strong centralized management.
Kraft Foods Inc. and KFG, through their boards of directors, officers, and
employees, centrally managed Kraft’s food and beverages operations, including
KPC and KFGB. Kraft Foods Inc. owned 100% of the stock of KFG, which in turn
owned 100% of the stock of KPC and KFGB. A. 227-28. Kraft’s business,
including KPC and the IP operations, was controlled and centrally managed by
“interlocking” boards of directors and officers controlled by KFG. A. 227-28.
KFG and its affiliates, including KPC and KFGB, had interlocking boards of
directors. A. 227-28. There was also considerable overlap among the officers
of the Kraft family of corporations during that time period. A. 227-28.
The high level of centralized management also provided substantial
economies of scale for Kraft. Interlocking directors and officers are evidence of
a unitary business due to the resulting centralized management and functional
integration. Gannett, 2008 ME 171, ¶ 25, 959 A.2d 741; Citizens Utils. Co. of Ill.
v. Dep’t of Rev., 488 N.E.2d 984, 990 (Ill. 1986). Such an interlocking
management structure is also a classic example of functional integration. See
Gannett, 2008 ME 171, ¶ 25, 959 A.2d 741.
42
Kraft claims that KPC had more autonomy than the other affiliates in its
day-to-day operations. Bl. Br. at 32-33. The record belies that claim. A. 206-
07, 219-25. Even if it were true, however, as the Supreme Court made clear,
“mere decentralization of day-to-day management responsibility and
accountability cannot defeat a unitary business finding.” Container, 463 U.S. at
180 n.19; see Gannett, 2008 ME 171, ¶ 17, 959 A.2d 741; Citizens Utils., 488
N.E.2d at 990 (centralized management found despite fact that “day-to-day
management of operating subsidiaries is controlled by local managers”). “The
difference,” the Supreme Court explained, “lies in whether the management
role that the parent does play is grounded in its own operational expertise and
its overall operational strategy.” Container, 463 U.S. at 180 n.19.
Here, the record shows that Kraft was a food/beverage products business
with historical expertise and experience in frozen pizza operations. Kraft
stipulated that “KPC’s growth strategies and strategic priorities during 2008
and 2009 were consistent with, and stemmed from, the business strategies of
Kraft Foods Inc. and affiliates.” A. 228. Like Gannett and Container, Kraft’s
overall operational strategy included manufacturing and selling frozen pizzas.
Also like Container and Gannett, Kraft’s headquarters included specialists
who provided assistance to all of its operating units in various phases of their
operations, and shared its expertise with KPC and other affiliates. A. 219-228.
43
As in Container and Gannett, the centralized management of Kraft’s frozen pizza
operations was grounded “in its own operational expertise and its overall
operational strategy.” Container, 463 U.S. at 180 n.19.
b. Functional integration and economies of scale.
Functional integration refers to transfers between or pooling among
business segments that significantly affect their business operations. Gannett,
2008 ME 171, ¶ 18, 959 A.2d 741. Frozen pizza was in the same general line of
business as the rest of Kraft’s packaged food and beverage operations. And as
shown above, there was a synergy between KPC and KFGB regarding the pizza-
related IP – the very assets sold to Nestle. A. 215-17.
i. KFG provided centralized services to all Kraft affiliates.
Kraft’s affiliates were functionally integrated in various ways. During
2008-2010, KFG included specialists who provided assistance to all of Kraft’s
operating units in various phases of their operations. For example, the tax
group at KFG prepared federal and state income tax returns for all corporations
in the Kraft family. A. 199-200. Other services provided to Kraft affiliates
(including KPC) by specialists at KFG included legal, internal audit, treasury,
and risk management services. A. 220-21. Treasury services included
managing and overseeing the cash management system described below,
which handled billions annually. A. 221.
44
In recognition of the value flowing to KPC from the provision of these
centralized services, KPC paid tens of millions of dollars yearly to KFG. For
example, in 2009, KPC paid $104 million for various centralized services and
shared facilities. A. 224. In 2010, KPC paid $61 million in expenses for
centralized services and shared facilities (Nestle sale closed on March 1, 2010).
A. 223-24. Many other Kraft corporations were also billed millions for services
performed by KFG corporate personnel in 2009 and 2010 and for using shared
facilities. A. 198-99, 219, 224.
The Kraft affiliates did not negotiate the amounts they were charged;
those amounts were determined solely by KFG, which calculated the amount of
each corporation’s allocation based on various metrics, not the value of the
services actually rendered. A. 219-220.
As this Court and other courts have held, the provision of intercompany
services was a form of centralized management by Kraft, which provided to its
affiliates the services that a truly independent business would perform for
itself. See Gannett, 2008 ME 171, ¶¶ 20-21, 959 A.2d 741; Earth Res. Co. of
Alaska v. Dep’t of Rev., 665 P.2d 960, 968-70 (Alaska 1983). The flow of value is
self-evident – and proven by the hundreds of millions of dollars billed to Kraft
affiliates annually.
45
The provision of centralized services created economies of scale and
showed functional integration. Gannett, 2008 ME 171, ¶ 21, 959 A.2d 741;
Container, 463 U.S. at 179-80 (fact that parent provided services to subsidiaries
was evidence of unitary business).
Moreover, KPC used the valuable DiGiorno and Delissio trademarks and
the patents for the frozen pizza business (owned by KFGB) for free. Other Kraft
affiliates paid more than $2 billion in royalties annually to use trademarks
owned by KFGB. A. 214-15. The enormous flow of value to KPC from this
favorable inter-company arrangement is obvious.
Additional integration resulted from the overlap between Kraft affiliates
as to R&D and IP protection/management provided by KFGB, as shown above,
including the sharing of expertise. Further, legal services provided by KFG
additional economies of scale and functional integration. See Container, 463
U.S. at 173 n.9 (fact that parent corporation’s employee negotiated a contract
on behalf of subsidiary was evidence of unitary business); Gannett, 2008 ME
171, ¶ 22, 959 A.2d 741.
ii. Kraft’s business operations were linked.
Significant economies of scale resulted from a variety of business
arrangements at Kraft. For example, there were common employee benefit
plans and retirement plans applicable to all Kraft employees, including those at
46
KPC. Common health and benefit plans are evidence of a unitary business due
to the resulting functional integration and economies of scale. Gannett, 2008
ME 171, ¶ 23, 959 A.2d 741. KFG acted as the purchasing agent for KPC and
other affiliates, negotiating with third parties to procure the raw materials used
by all Kraft affiliates, including KPC. A. 222-23.
The mutual interdependence of Kraft affiliates is further shown by its
financing. Kraft used a “cash management system.” A. 225. This was a common
pool of cash on which any of the Kraft affiliates could draw (interest free) to pay
their capital expenses or their operating expenses. At some point every
business day, the excess cash held by every Kraft corporation was “swept” into
a single bank account owned by KFG. A. 225. This huge pool of cash was
available to all affiliates. No interest was charged for using this money. A. 225.
The cash management system created a big piggy bank on which Kraft affiliates
drew to run their operations. Numerous courts, including this Court, have held
that such a system creates economies of scale and functional integration.
Gannett, 2008 ME 171, ¶ 26, 959 A.2d 741; Citizens Utils., 488 N.E.2d at 991-92.
6. The few facts and legal arguments on which Kraft relied do not amount to substantial authority or establish reasonable cause.
The few facts on which Kraft relied to support its penalty abatement
arguments are largely not supported by the record or disputed by the Assessor.
47
In any event, when compared to the overwhelming undisputed facts showing
that KPC was part of the Kraft unitary business, these facts do not amount to
substantial authority or establish reasonable cause for Kraft’s contention that
$3+ billion in income earned by a unitary business was non-unitary income.
For example, the Direct Store Delivery model (Bl. Br. at 32) was not unique
to KPC. KFG also used that model to deliver Nabisco products. A. 206-08.
The suggestion that KPC provided a material amount of its own R&D (Bl.
Br. at 32) is contrary to the stipulated record. KFGB provide R&D for KPC and
all Kraft affiliates during the period at issue here. A. 212-13, 218-19.
The conclusory allegation that KPC’s frozen food products were not
“primarily branded or marketed as ‘Kraft’ products” (Bl. Br. at 33) is
contradicted by the record. A. 156, 198. The “Kraft” brand appeared on the
packaging for KPC’s frozen pizzas. A. 198. The “Kraft” name was also
prominently featured as part of the Jack’s and Delissio brand names. A. 198.
Any minor differences in the degree of autonomy in day-to-day
management among the various Kraft affiliates are immaterial.13 “[M]ere
decentralization of day-to-day management responsibility and accountability
cannot defeat a unitary business finding.” Container, 463 U.S. at 180 n.19.
13 The record contradicts Kraft’s allegation that KPC was “unique among the Kraft affiliates in terms of independence,” see Bl. Br. 33. A. 206-07, 219-25.
48
Kraft’s reliance on the fact that KPC marketed DiGiorno, Delissio, and the
other frozen pizzas sold by KPC undermines its argument that KPC was not part
of the Kraft unitary business. KPC did not own the DiGiorno or Delissio
trademarks or the any of the patents (KFGB did), but spent money to market
those frozen pizzas, thereby increasing the value of the related IP. That is the
essence of a unitary business. See Gannett, 2008 ME 171, ¶ 13, 959 A.2d 741.
Kraft’s allegation that KPC “itself procured all but a small number of the
ingredients and raw materials used to produce its frozen pizzas” (Bl. Br. at 33)
is contrary to the stipulated record. A. 126, 222-23.
In short, the few facts that Kraft offers are largely unsupported and, in
any event, fall far short of constituting substantial authority or establishing
reasonable cause to exclude from Maine income tax $3+ billion from the Nestle
sale on the theory that KPC was not part of the Kraft unitary business.14 The
overwhelming record facts show that KPC was part of Kraft’s unitary business.
Kraft contends that it has presented a “well-reasoned construction of the
statute,” referring to the statutory definition of a “unitary business.” Bl. Br. at
29. But that contention is a red herring because the “construction” of that
statute is not in dispute in this case.
14 The Board’s 2015 decision does not constitute “substantial authority.” The authority must have existed when Kraft filed its 2010 Maine return in October 2011. See 26 C.F.R. §§ 1.6662-4(d)(2), (3).
49
Kraft also claims it has provided a “well-reasoned basis” for treating KPC
as non-unitary. Bl. Br. at 34. But that is not operative standard. To prevail on
its substantial authority defense, Kraft must show that “the weight of the
authorities supporting the treatment is substantial in relation to the weight of
authorities supporting contrary treatment.” John Swenson Granite, 685 A.2d at
429 n.3. “Substantial” means something more than a reasonable basis.15 Id.
In sum, the Superior Court erred in ruling that Kraft proved there was
substantial authority to exclude the $2+ billion in income recognized by KPC.
D. Kraft did not provide substantial authority to support any claim that the $1.3 billion earned by KFGB was “non-unitary” income.
Roughly $1.3 billion of the income at issue was earned by KFGB – the
unitary affiliate that managed and protected all the IP that was sold to Nestle
(and owned most of that IP). At the trial court, Kraft failed to offer any
explanation as to why that $1.3 billion was non-unitary income. The court
properly upheld the penalty as to the amount of the First Assessment that was
15 In a footnote, Kraft argues that the $3+ billion was “non-business income” under other states’ income tax laws and therefore that income should not be subject to Maine income tax. Bl. Br. at 34 n.12. This argument suffers from several fatal flaws. First, Maine does not have a business/non-business distinction in its corporate income tax law – it was repealed 31 years ago. P.L. 1987, ch. 841, §§ 9-13 (eff. Aug. 4, 1988). Second, as Kraft points out, non-business income is supposed to be allocated to one state – and Kraft did not allocate this $3+ billion gain to one state.
50
attributable to Kraft’s failure to include that $1.3 billion as subject to Maine
income tax. A. 29-30.
On appeal, Kraft now seeks to show why it is “irrelevant” that KFGB is the
corporation that recognized this income, not KPC. Bl. Br. at 35-37. The Court
should not consider these arguments because Kraft did not make them below.
See Foster, 2008 ME 21, ¶ 22, 940 A.2d 1102.
In any event, the fact that KFGB, not KPC, earned that $1.3 billion is
relevant to Kraft’s penalty claim because of Kraft’s arguments here. Kraft’s
defense to the penalty has centered on its contention that the corporation KPC
was separately managed and autonomous – and thus (Kraft claims) arguably
not part of its unitary business. Bl. Br. at 31-34. Kraft made no such argument
about KFGB, the corporation that managed and protected Kraft’s IP (including
the IP sold to Nestle) and provided R&D for Kraft. Kraft’s defense to the penalty
ignored KFGB and the $1.3 billion earned by KFGB on the sale of IP that KFGB
had owned, managed, and protected.
The Assessor agrees with Kraft that under Meadwestvaco Corp. v. Illinois
Department of Revenue, 553 U.S. 16, 24-26 (2008), and other Supreme Court
decisions, the focus of the unitary business inquiry is on transfers of value
among affiliated corporations, not on the separate legal existence of
corporations. The record proves that, consistent with those decisions, (1) Kraft
51
was a unitary business and (2) the gain from the Nestle sale derived from the
mutually interdependent activities of that unitary business, including the
activities of KFG, KFGB, and KPC. A. 214-19. The trial court’s focus on KFGB in
rejecting Kraft’s argument for penalty abatement is consistent with those cases.
Thus, as the court found, Kraft “offered no substantial authority for failing
to report as income derived from a unitary business” KFGB’s $1.3 billion gain
from the sale to Nestle. A. 29-30. As such, the assessed tax resulting from
Kraft’s failure to include that income on its Maine return as derived from the
unitary business was subject to the substantial understatement penalty. A. 30.
III. The Second Assessment was timely.
The Court reviews de novo whether a dispute of material fact exists and
whether the entry of a summary judgment was proper as a matter of law.
Angell, 2014 ME 72, ¶¶ 16-17, 92 A.3d 1154. Kraft has the burden of proof.
36 M.R.S.A. § 151(2)(G) (Supp. 2018). The Superior Court conducted a de
novo proceeding on Kraft’s petition for review and made its own
determinations as to all questions of fact and law.
The Second Assessment involves the Assessor’s disallowance of
$306,729,484 that Kraft claimed as a “capital loss carryforward” on its 2010
Maine return. Kraft has conceded that it had no legal basis to reduce by more
than $306 million the amount of income that should have been taxable by
52
Maine. Kraft made up a deduction that does not exist under Maine law and
reduced the amount of income subject to tax by more than $306 million. That
is an astounding concession.
Kraft nonetheless argues that Maine should not be able to tax this
$306,729,484 of income due to the statute of limitations. The ordinary statute
of limitations for the Assessor to make an assessment of tax is three years from
the date the taxpayer filed its return, but is six years when taxpayers
substantially underreport their tax liability.
Section 141(2) provides that:
An assessment may be made within 6 years from the date the return was filed if the tax liability shown on the return, after adjustments necessary to correct any mathematical errors apparent on the face of the return, is less than 1/2 of the tax liability determined by the assessor.
Id. § 141(2). Thus, the statute of limitation is six years when the tax liability
shown on a return “is less than 1/2 of the tax liability determined by the
[A]ssessor.” There is no dispute that the tax liability shown on Kraft’s original
2010 Maine return ($367,402) is less than one-half of the tax liability
determined by the Assessor ($2,392,567).16
16 $2,392,567 = $367,402 (tax reported by Kraft on its return) + $1,832,717 (tax from First Assessment) + $192,448 (tax from Second Assessment). The tax liability shown on the return is $367,402, which is less than ½ of $2,392,567. ($367,402/$2,392,567 = 0.15).
53
In determining whether the 50% threshold is satisfied, however, the
Assessor “may not consider any portion of the understated tax liability for
which the taxpayer has substantial authority supporting its position.” 36
M.R.S.A. § 141(2). Kraft does not contend that it had any authority, much less
substantial authority, for the $306,729,484 it claimed as a CLC.
Nonetheless, if Kraft had substantial authority supporting its position
that the $3+ billion in income from the sale to Nestle was non-unitary income,
then that income may not be considered in calculating the 50% threshold, and
the Assessor agrees that the 50% threshold would not be reached in this case.
That is, the Second Assessment would not be timely if Kraft proved that it had
substantial authority supporting its filing position, where it excluded $3+
billion from the income subject to tax by Maine.
In applying section 141(2), the Superior Court held that the Second
Assessment was timely because Kraft lacked substantial authority to exclude
the $1.3 billion in income that KFGB recognized. A. 31. As a result, the tax
liability shown on Kraft’s 2010 Maine return ($367,402) was less than one-half
of the tax liability as determined by the Assessor when not considering that
portion of the understated tax liability for which, according to the trial court,
54
Kraft had supplied substantial authority (that tax liability would be roughly
$1,170,755).17 A. 31.
Thus, even assuming the Superior Court correctly ruled that Kraft had
substantial authority to subtract the $2 billion earned by KPC – but not the $1.3
billion earned by KFGB – the tax liability shown on Kraft’s 2010 Maine tax
return would be less than one-half of the tax liability as determined by the
Assessor when not considering that portion of the understated tax liability for
which Kraft was held to have supplied substantial authority. The Second
Assessment was timely. A. 31.
17 The tax liability determined by the Assessor, when not considering that portion of the understated tax liability for which, according to the trial court, Kraft had substantial authority, would be roughly $1,170,755: $367,402 (tax liability reported by Kraft on its return) + (roughly) $610,905 (1/3 of tax from First Assessment – since Kraft lacked substantial authority as to $1+ billion of the $3+ billion adjustment to Kraft’s income made on audit) + $192,448 (tax from Second Assessment). The tax liability shown on the return is $367,402, which is far less than ½ of $1,170,755. ($367,402/$1,170,755 = 0.31).
CONCLUSION
For the reasons stated above, the Assessor asks that the Court (1) affirm
the Superior Court's Order rejecting Kraft's alternative apportionment claim,
(2) affirm the Superior Court's order to the extent the court upheld part of the
substantial understatement penalty in the First Assessment, (3) vacate the
Superior Court's Order to the extent that the court abated part of the penalty
in the First Assessment and remand for entry of judgment in favor of the
Assessor as to the entire penalty, and ( 4) affirm the Superior Court's order as
to the Second Assessment.
Dated: May 13, 2019
AARON M. FREY Attorney General
_./)
55
\ THOMAS A. KNO Assistant Attorney General Maine Bar No. 7907 KIMBERLY L. PATWARDHAN Assistant Attorney General Maine Bar No. 4814 6 State House Station Augusta, ME 04333-0006 (207) 626-8800 Attorneys for State Tax Assessor
56
CERTIFICATE OF SERVICE
I, Thomas A, Knowlton, Assistant Attorney General for the State of Maine, do hereby certify that I have served two copies of this brief by depositing them in the U.S. mail, postage prepaid, addressed as follows: Jonathan A. Block, Esq. Pierce Atwood, LLP 254 Commercial Street Portland, ME 04101 Dated: May 13, 2019 /s/ Thomas A. Knowlton Thomas A. Knowlton Assistant Attorney General
57
STATE OF MAINE SUPREME JUDICIAL COURT Sitting as the Law Court Docket No. BCD-18-524
STATE TAX ASSESSOR, Petitioner/Appellee/Cross-Appellant v. KRAFT FOODS GROUP, INC., et al., Respondents/Appellants/Cross- Appellees.
CERTIFICATE OF SIGNATURE
I am filing the electronic copy of a brief with this certificate. I will file
the paper copies as required by M.R. App. P. 7A(i). I certify that I have
prepared (or participated in preparing) the brief and that the brief and
associated documents are filed in good faith, conform to the page or word
limits in M.R. App. P. 7A(f), and conform to the form and formatting
requirements of M.R. App. P. 7A(g).
Name of parties on whose behalf the brief is filed: State Tax Assessor
Attorney’s name: Thomas A. Knowlton
Attorney’s Maine Bar No.: 7907
Attorney’s email address: [email protected]
Attorney’s street address: 6 State House Station, Augusta, ME 04333
Attorney’s business telephone number: (207) 626-8832
Date: May 13, 2019
ADDENDUM
Certain affiliates of Kraft Foods Inc.
Kraft Foods Inc. (no comma between "Foods" and "Inc."): parent corporation
KFG = Kraft Foods Global, Inc. (wholly owned subsidiary of Kraft Foods Inc.)
KPC = Kraft Pizza Company (wholly owned subsidiary of KFG)
KFGB =Kraft Foods Global Brands, Inc. (wholly owned subsidiary of KFG)
58
( (
I
~ ,t;;ijqq~
0
m
l'l ~ ~ ] ~ j l
~ 1--J L_J
~JI j l :1
~ if r- !JI ~u
f ~ 1~ ~ j r-
Jf /- 1 ~
1-
c 01 fJ-l 1
Pl H !
Jl I ~l I- lj h j
I-
i I ~ l 1 r
I- ~J A ! ' I-g I-
~
!J J ~
I-~1 !
~ ~ r11 l...i i1 Pl
TRIAL EXHIBIT 6
~1~J ijl
i1~l ~ t
J J ~ ~-i ~g J ~, ~:
<:
J ~ A
1
·"'"
~ ..., 0 0 -_, t;
,--...
.r--. TMJNJJ./Y])J1AFI-FORDJSClJSSIONPTJJ1J'OSESONIT
UNITED STATES
l
('2 of4) (as ofl2/31/Q9)
zoo4.[
PenllreT~
Sribsiiliazy, -
D°""""'
.I
Kraft Foods Global.Br.mas, Inc.
De!=
Kml:Foods Global Brands !LC
Dd==
:.I l
:.I
OMFC Service Company
De!aw=
\
Th.eYuban CoffueC-
Dela-•
KxaftFoods Holdings Services:.
me. Nabisco Roy:il AxgentinaU.C
Dolaw.= Dolawzre
------~-------Branch
' ' ' ' ' ' ' ' ' ' L--------~J
.--.. ,_ . .-.-..,, __
,,....._ . ~ .. CONFIDENTIAL lNT:ERNAL USE ONLY
[ KraftPoodsl'o.c.. v"""' l X:rafl:Foods Global, In°D-= I
I
_]_
PoDioltallim Cheese Compzci.y
D°""""'"
:r VJ.ct Th. En.pall
& Co •• !o.c. ~-
1---.-.- --=r Phenix.Leasing PhenixMzi>g=t
Corporati.Oll Coipora.tion
Delawate Delaware' '---------
I Tasmuo I l Comp~ J=
~~~ Kml:Food :mg,.dionts
Corp. ~
l
Seven Seas :Foo~Inc.
D&w=
l
Kra:ft Foods R&D1T:o.C..
D&w= , ______ I l -------~
' ' ' ' ' ' : Branch i ' ' ' ' ' ' l..-------~l
Page 60